Auction Design

Peter Cramton Professor of Economics, University of Maryland

www.cramton.umd.edu

15 December 2014

1

Auction design

• Establishes rules of market interaction

• Economic engineering

– Economics

– Computer science

– Engineering, operations research

Auction design accomplishments

• Improve allocations

• Improve price information

• Reduce risk

• Enhance competition

• Mitigate market failures

Applications

• Spectrum auctions

• Electricity markets

• Natural resource auctions (timber, oil, etc.)

• Emission allowance auctions

• Financial securities

• Procurement

Objectives

• Efficiency

• Transparency

• Fairness

• Simplicity

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Principle

“Make things as simple as possible, but not simpler” -- Albert Einstein

Spectrum

Spectrum auctions

• Many items, heterogeneous but similar

• Competing technologies and business plans

• Complex structure of substitutes and complements

• Government objective: Efficiency

– Make best use of scarce spectrum

– Address competition issues in downstream market

Key design issues

• Establish term to promote investment

• Enhance substitution – Product design

– Auction design

• Encourage price discovery – Dynamic price process to focus valuation efforts

• Encourage truthful bidding – Pricing rule

– Activity rule

Simultaneous ascending auction

Prepare

12

Italy 4G Auction, September 2010 470 rounds, €3.95 billion

• Auction conducted on-site with pen and paper

• Auction procedures failed in first day

• No activity rule

13

Thailand 3G Auction, October 2012

• 3 incumbents bid

• 3 nearly identical licenses; can only win one

• Auction ends at reserve price + 2.8%

14

US AWS-3 auction, 65 MHz, after 91 rounds $43.7 billion, $2.65/MHzPop (paired)

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Electricity

Goals of electricity markets

• Short-run efficiency

– Least-cost operation of existing resources

• Long-run efficiency

– Right quantity and mix of resources

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Challenges of electricity markets

• Must balance supply and demand at every instant at every location

• Physical constraints of network

• Absence of demand response

• Climate policy

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Three Markets

• Short term (5 to 60 minutes) – Spot energy market

• Medium term (1 to 3 years) – Bilateral contracts

– Forward energy market

• Long term (4 to 20 years) – Capacity market (thermal system)

– Firm energy market (hydro system)

• Address risk, market power, and investment

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Long-term market: Buy enough in advance

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Product

• What is load buying?

– Energy during scarcity period (capacity)

• Enhance substitution

– Technology neutral where possible

– Separate zones only as needed in response to binding constraints

• Long-term commitment for new resources to reduce risk

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Pay for Performance

• Strong performance incentives

– Obligation to supply during scarcity events

• Deviations settled at price > $5000/MWh

• Penalties for underperformance

• Rewards for overperformance

• Tend to be too weak in practice, leading to

– Contract defaults

– Unreliable resources

• But not in best markets: ISO New England, PJM

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The Future of Mobile Broadband

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The future…as with electricity: multiple opportunities to contract

• Long term: investment market like today

• Medium term: one month to three years

• Short term (spot market)

– One day

– One hour

– 5 minutes

– 4 seconds

– (10 milliseconds, 10 microseconds, …?)

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Conclusion

• No auction design is perfect • Design must be customized for setting

– Simultaneous ascending clock • Simple settings (upcoming UK)

– Combinatorial clock • Packaging is essential (UK 4G, Canada 700 MHz)

– Two-sided clock • Incentive auction in US

• Never ignore essentials – Encourage participation – Demand performance – Avoid collusion and corruption

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Telecom:

Energy:

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Auction spectrum

Pay for performance